This Selected Issues paper examines the factors behind the recent surge in capital flows in Japan. The paper presents econometric evidence on the influence of these capital flows on the medium-term dynamics of the yen. It finds that in the case of the yen–dollar rate, nontrade factors affecting capital flows are likely to delay the adjustment of the yen-dollar rate to its long-term equilibrium value. The paper also draws on recent international experiences and trends to identify and review some of the key tax issues and options for meeting these challenges.

Abstract

This Selected Issues paper examines the factors behind the recent surge in capital flows in Japan. The paper presents econometric evidence on the influence of these capital flows on the medium-term dynamics of the yen. It finds that in the case of the yen–dollar rate, nontrade factors affecting capital flows are likely to delay the adjustment of the yen-dollar rate to its long-term equilibrium value. The paper also draws on recent international experiences and trends to identify and review some of the key tax issues and options for meeting these challenges.

V. Japan: Boosting Productivity in Services—Priorities for Deregulation1

1. Japan’s service sector accounts for around 70 percent of GDP and employment, and its share has been steadily growing.2 During 2000–05, Japan’s economy grew on average by 1.6 percent: the service sector accounted for around two-thirds of overall growth. The main non-financial service sectors are medical and healthcare, restaurants and hotels, education, wholesale and retail trade, real estate, and transport and communications.

uA05fig01

Service Sector Share in GDP and Employment

(in percent)

Citation: IMF Staff Country Reports 2007, 281; 10.5089/9781451820706.002.A005

Source: Cabinet Office.

2. Overall productivity is improving, but productivity in services remains well below that of manufacturing and below the level in the United States. During 1995–05, nonmanufacturing labor productivity in Japan grew by 1 percent annually compared to almost 3½ percent in manufacturing; total factor productivity (TFP) has also lagged well behind (CAO, 2007).

uA05fig02

Labor Productivity Gap between Japan and the United States

(by industry)

Citation: IMF Staff Country Reports 2007, 281; 10.5089/9781451820706.002.A005

Source: Cabinet Office based on EU KLEMS database.

3. Japan has reaped significant rewards from past deregulation, and the potential benefits from further broad-based deregulation are substantial. CAO (2007) estimates the benefits from deregulation of several industries starting in the 1990s to be around 5 percent of national income. Estimates of the potential static gains from regulatory reform over the medium-term range from 5–8 percent, and dynamic gains (i.e., additions to potential growth) could be substantial.3 Further deregulation holds significant promise for boosting Japan’s growth potential and international competitiveness.

4. This chapter examines impediments to productivity growth in distribution, network industries, and health. Sector specific issues and economy-wide factors that inhibit competition and market contestability, and limit the role of information and communications technology (ICT) and innovation, have combined to depress productivity in the service sectors. Reflecting the broad consensus about the benefits of deregulation, a worldwide trend towards more market-friendly regulatory frameworks and policies has prevailed since the 1980s.4 The Japanese authorities recognize the need for pushing ahead with regulatory reforms and have been active in this area.

A. Economy-Wide Reform Priorities

5. Summary indicators of structural rigidities or competitiveness suggest that Japan is in line with many European countries, but lags the United States and United Kingdom. Japan’s rankings, according to a broad range of competitiveness indicators, have improved in recent years.5 The OECD’s summary index of the restrictiveness of product market regulations (PMR) also improved but Japan did not make it into the list of “relatively liberal” countries.6

uA05fig03

OECD Product Market Regulation Indicator

(ranging from 0 (least restrictive) to 6 (most restrictive))

Citation: IMF Staff Country Reports 2007, 281; 10.5089/9781451820706.002.A005

Source: OECD.

6. Key economy-wide factors affecting service-sector productivity include: labor market flexibility, competition, entrepreneurship, ICT use, and the framework for innovation. Labor market flexibility facilitates the move of labor and other resources to more productive sectors. Bloom et al. (2007) suggest that labor market flexibility and other factors that promote organization change in the United States allow U.S. firms to use ICT more effectively and help explain their faster productivity growth (Table V.1). The combination of these factors likely acts in a complementary and mutually reinforcing way to enhance productivity.

Table V.1.

Gross Value Added Growth and Contributions

(Annual average volume growth rates, in percent)

article image

Labor market flexibility

7. Labor market flexibility has improved but much remains to be done. The increasing share of “non-regular” workers in Japan to around one-third of total workers, improvements to the social safety net, the broader coverage of industries served by private placement agencies, and the longer dispatch period for short-term hires have all enhanced labor market flexibility. Still, labor market rigidities persist as long-standing features of the Japanese employment system, such as “lifetime employment” and “seniority-based wages,” (Callen and Nagaoka, 2002) will take time to change. Moreover, Japan ranks tenth in terms of employment protection in the OECD (OECD, 2006) and, according to the World Bank, first among the major industrial countries in terms of the difficulty of dismissing workers.7

8. More flexible work hours and practices, compensated dismissals, and greater portability of pensions could enhance labor flexibility. Immigration policy could also play a role in easing labor and skill shortages, while a further opening of the education sector to competition could accelerate human capital development.8

Overall competition policy

9. The government has taken recent steps to enhance competition. In January 2006, a strengthened anti-monopoly law took effect, while steps have been taken to enhance the resources and independence of the Japan Fair Trade Commission (JFTC). Some early results are evident from reports of large savings in public procurement and bid rigging prosecutions. The Diet is also reviewing bills to address “amakudari”—the practice of retiring senior civil servants joining a large corporation—which raises the risk of regulatory capture. Despite this progress, several key service industries remain sheltered (from domestic or foreign entry), particularly health, education, transport and electricity (Jones and Yoon, 2006). Japan also still features relatively low shares of imports and foreign direct investment compared to other industrial economies which may serve to limit the benefits of competition on productivity.

10. As suggested by the OECD and others, competition could be further strengthened by:

  • Further enhancing competition policy, including through adequate provision of resources to the JFTC; the monitoring of ex-post indicators of competition (such as margins and concentration); and reviewing the effectiveness of the JFTC’s new or enhanced tools, such as higher penalties (surcharges) and the leniency program.9

  • Opening up “government-driven” markets where possible, such as medical services, nursing care and education, through further deregulation and more extensive use of market testing.

  • Accelerating the economy-wide roll-out of successful Special Zones reforms. There are some 400 Special Zones where deregulation is implemented on a pilot basis. Reforms to allow joint-stock companies to operate hospitals and schools and reforms related to some social services could be considered for more rapid economy-wide rollout.

  • Implementing measures to introduce competition into markets with strong incumbents and the establishing independent sectoral regulators in some industries could also help in this regard (OECD, 2006).

  • Promoting reforms to facilitate inward FDI, including by accelerating regulatory reforms in product markets—particularly by reducing entry barriers to both domestic and foreign firms in sectors such as health, education, transport, and electricity; and further easing restrictions on FDI, especially in the service and network industries (Jones and Yoon, 2006).10

Barriers to entrepreneurship

11. The entry (and exit) of new business is key to growth and innovation; however, entrepreneurship and the role of venture capital are very limited in Japan (Callen and Nagaoka, 2002; OECD, 2006). Business start-ups account for around 4 percent of Japanese firms compared with around 10 percent and 14 percent respectively in the United States and Europe. Japan also fares poorly in international rankings of entrepreneurship, e.g. Japan was last in the International Institute for Management Development (IMD)’s entrepreneurship rankings, and second from last in the Babson Colleague Global Entrepreneurship Monitor.

12. Factors likely to affect new business start-ups include the availability of risk capital, the legal and administrative framework, and demographics (i.e., younger people may be more likely to take risks and be entrepreneurial). Despite several policy and capital market developments favoring the financing of start-ups (Callen and Nagaoka, 2002), venture capital investment as a share of GDP was the second lowest in the OECD during 2000–03, while the share invested in hi-tech sectors was about half the OECD average. According to the World Bank Doing Business database, starting a business in Japan involves more processes, takes longer, and costs more than the average in OECD countries.11 These indicators highlight further developing capital markets and reducing legal/administrative burdens as priorities for supporting startups and entrepreneurship.

Role of ICT and innovation

13. ICT is an important driver of growth in Japan (Box V.1), both in terms of its direct contribution to production and indirectly through efficiency gains. During 1980–04, ICT capital deepening is estimated to have contributed close to a ½ percentage point to gross value added growth. However, ICT’s contribution to capital deepening and overall TFP has declined progressively since the 1980s, before recovering somewhat during 2000–04 (Table V.1).12 Some possible factors include labor rigidities and organizational structures that limit the scope for ICT productivity gains and its spread to other industries (Motohashi 2005, 2007a). In contrast, the United States has enjoyed productivity growth in both sectors that intensively use ICT (such as retail and wholesale trade, and financial services) as well as those that produce ICT. In other countries, including Japan, the ICT gains have been isolated mainly to the ICT producing sectors. Recent research suggests that the United States’ higher productivity growth from ICT since the mid-1990s is related to the organization of U.S. firms that permit more efficient use of new technologies (Bloom et al., 2007).

14. The OECD has highlighted the need to upgrade Japan’s innovation system to boost productivity. It points out that R&D intensity in Japan is relatively high, but the returns are low. Possible reasons include: the weak link between business and research organizations; the low degree of trade and investment openness which limit exposure to outside knowledge and ideas; a rigid education system; investor risk aversion; and regulatory frameworks in product markets, labor markets, competition policy and finance that fall short of supporting innovation (OECD, 2006). Conway and Nicoletti (2006) estimate the impact of nonmanufacturing product market regulations on ICT-using sectors in Japan to be among the highest in the OECD area. With knowledge-intensive industries accounting for only 17 percent of value added in Japan (compared with 23 percent in the United States) and the share of services in business R&D the lowest in the OECD, the level and efficiency of R&D investment may be important factors behind the low productivity in services.

uA05fig04

Share of Services in Businesses R&D, 2003

(in percent)

Citation: IMF Staff Country Reports 2007, 281; 10.5089/9781451820706.002.A005

Source: OECD Science, Technology and Industry: Scoreboard 2005.

15. Realizing fully the benefits from ICT and innovation would require broad ranging reforms to strengthen the framework conditions, including to the labor and product markets and the competition and regulatory frameworks. These could be augmented by measures to improve organizational flexibility within firms; further develop the financial sector to promote investment in intangible assets and risk/venture capital; increase openness to imports and direct investment; improve education and knowledge diffusion; and promote innovation-specific policies (OECD, 2006).13

ICT and Service Sector Productivity

ICT is an important driver of growth in Japan, contributing extensively to production, investment and exports (Jorgensen and Motohashi, 2005). ICT can contribute to growth directly through ICT capital deepening and TFP growth in ICT production, and indirectly through ICT use in other sectors (which would boost overall TFP if ICT use results in improved efficiency).

Table 5.1 shows that the contribution of ICT capital deepening to growth has progressively declined: from 0.5 percent (which was among the highest in the major industrial countries) during the 1980s, to 0.2 percent (among the lowest) by 2000–04. The contribution of TFP to growth also declined sharply from the being the highest of these countries in the 1980s to the lowest in 1990s, but recovered somewhat during 2000–04. TFP growth in ICT production is the highest among the major OECD economies (averaging nearly 7½ percent during 1995–2004), but because the share of the ICT production is small (as in most OECD countries), its contribution to overall TFP is limited.

uA05fig05

Major Industrial Countries: TFP growth and ICT capital services growth, 1995-2004

Citation: IMF Staff Country Reports 2007, 281; 10.5089/9781451820706.002.A005

Source: Fukao and Miyagawa (2007) using the EU KLEMs

In terms of the indirect effects of ICT on growth in Japan, Fukao and Miyagawa (2007) point to the close correlation between ICT capital services growth and TFP growth for 6 major industrial countries as evidence that ICT investment is associated with economic efficiency (Bloom et al. (2007) for empirical studies that further establish this link).

Low ICT capital deepening in services is likely to be an important factor behind the low productivity growth in services. Various studies (Fukao and Miyagawa, 2007) suggest the full realization of the direct and indirect benefits of ICT requires the simultaneous accumulation of complementary intangible assets, such as human capital, knowledge capital, organization capital, and social capital). Fukao et al. (2007) estimate that the intangible assets have grown more slowly in Japan, and that the ratio of intangible to tangible assets in Japan is much lower than in the United States. Various indicators suggest ICT usage in Japan is also somewhat lower than in the United States and the United Kingdom. For example, the percentage of students in Japan using a computer at school regularly was among the lowest in the OECD (OECD, 2006) while the use of e-commerce in Japan is also relatively low.

Structural rigidities likely combine to limit the potential benefits from (and thus investment in) ICT and intangible assets. Studies indicate that structural rigidities such as lack of competitive pressures in some segments, product market rigidities, and labor market rigidities reduce the scope for benefits from (and thus the incentive to invest in) ICT and intangible capital. The financial sector, through limited provision of venture capital and reliance on collateralized lending, may also distort growth in intangible versus tangible assets. An OECD study found Japan to be one of the few countries in which framework conditions has a negative impact on R&D spending (OECD, 2006). This suggests that a comprehensive package of reforms would yield greater overall benefits than piece meal reforms.

B. Sector-Specific Priorities for Deregulation

16. Wholesale, retail, and personal and social services are the least productive among the service sectors. The breakdown of value added by sector (Table V.2) also shows low TFP growth in these sectors, and a relatively low contribution of ICT capital accumulation to growth.

uA05fig06

Contributions to Growth

(in percent; 2000-05 average)

Citation: IMF Staff Country Reports 2007, 281; 10.5089/9781451820706.002.A005

Source: Cabinet Office.1/ All industries excludes government services and private non-profit services to households.
Table V.2.

Japan: Gross Value Added Growth and Contributions

(Annual average volume growth rates, in %)

article image
Source: EU KLEMS database (http://www.euklems.net).

17. One reason may be that these sectors face weak competitive pressures. For example, Høj and Wise (2004) find mark-ups in the service sector, particularly construction and utilities, and the overall price level to be internationally high. This is also reflected in high concentration ratios and stability in market shares.

18. These sectors also have more restrictive product market regulations than the OECD best performers. The OECD’s nonmanufacturing product market regulation indices (NMR) show that Japan and the rest of OECD have made progress in deregulation (Figure V.1) and that Japan was a relatively early mover in terms of deregulating its telecoms, rail and airlines. However, the timing and extent of reforms still lag that of the United States and the United Kingdom, and for energy, transport, and communications (ETCR), Japan is not on the list of “relatively liberal” countries. The impact of these nonmanufacturing sector regulations on the manufacturing sector (based on the extent of anti-competitive regulation in these nonmanufacturing sectors and their importance as suppliers of intermediate inputs to the manufacturing sector) are estimated to be the fourth largest in the OECD area (Conway et al., 2006).

Figure V.1.
Figure V.1.

OECD Non-Manufacturing Product Market Indices (NMR)

Citation: IMF Staff Country Reports 2007, 281; 10.5089/9781451820706.002.A005

Source: OECD.

19. Weak market contestability and the limited role of ICT may also partly explain the low level of productivity. Market contestability (important sectors such as healthcare and education are not open to either domestic or foreign investors) and barriers to greater ICT and innovation may also play a role. Based on low levels of productivity, the degree of restrictiveness in their regulatory framework, and the contributions to output and employment, the priority sectors for reform would be distribution (retail, wholesale, transportation) and network industries which are key inputs to other sectors. Added to these would be government services in sheltered sectors, particularly healthcare which now accounts for 8 percent of public spending and is rising.

Distribution (retail and wholesale trade and transportation)

20. Deregulation in distribution has focused on relaxing restrictions in retail and wholesale, and on licensing and store size. The result has been an increase in the number of large stores and discount outlets, and the replacement of “mom and pop” stores with vertically integrated franchises (Høj and Wise, 2004). In addition, steps have been taken to ease the licensing restrictions on liquor and drug sales, remove regulation on resale price maintenance for drugs, cosmetics, and other products, and relax restrictions on establishing large scale stores.14 Nevertheless, despite this progress, productivity in this sector remains relatively low at less than 60 percent of the U.S. level.

21. The OECD notes that certain trading practices imposed by producers, such as standard prices and rebates, may be restricting competition and that despite the rise in average store size, the number of large stores remains relatively low (Høj and Wise, 2004).15 A new Large Scale Retail Store Locating Law was introduced in 2000 which eased restrictions on business hours, location, and focus on environmental impacts (such as traffic).16 This move was welcomed, although some business groups have raised concerns about the unequal implementation of regional regulations related to large store location (i.e., resulting from local interpretation of construction, safety and environmental regulations).

22. Productivity in distribution could be raised through:

  • More consistent and transparent application of government regulations on large stores location at all levels of government (United States-Japan, 2007). Empirical studies highlight the greater efficiency of large stores (McKinsey Global Institute, 2000) and the importance of entry and exit of firms.17 Closely monitoring the application of regulations on large store locations and a timely assessment of their impacts on efficiency in the retail sector would help build support for further easing of regulations.

  • Fuller utilization of ICT, which is a major driver of productivity in retail trade (Doms, Jarmin, and Klimek, 2004; Bloom et. al, 2007). Removing the barriers to accumulating complementary intangible assets (Box V.1) and greater labor and product market flexibility would help promote a greater diffusion of ICT benefits.

23. Deregulation in transportation has also proceeded, but user charges remain high. In the 1990s, entry barriers and charges in the trucking, airline, rail and taxi industries were lowered, and vehicle registration and inspection were simplified. Harbors were also allowed to operate around the clock; the Japan Highway Public Corporation and Narita Airport Corporation were privatized, and landing changes at Narita were reduced in 2005. Nevertheless, despite these improvements, airport, port, and toll road charges in Japan remain high by international standards.18

24. Measures to promote greater competition could lower transportation costs further. As recommended by the OECD, this could be done by deregulating the distribution, pricing and settlement of airfares, promoting greater competition between ports, including through outright privatization; and operating toll roads on a cost recovery basis rather than through cross subsidization which would lead to more efficient development of highways.

Network industries

25. The network industries in Japan (electricity, gas, and postal services) are dominated by vertically integrated firms that have limited new entrants. In general, to ensure a market structure that promotes competition and nondiscriminatory access, the OECD has recommended that legal or ownership separation, rather than “accounting unbundling”, i.e., separate accounting of the vertically integrated utilities, be considered for the network industries. Creating independent sector regulators as part of an active ex-ante regulation for ensuring nondiscriminatory third party access could also spur greater competition (OECD, 2005). The next sections explore these issues in more details for the electricity, gas, and postal services and telecommunication sectors.

Electricity sector

26. The electricity industry in Japan is dominated by ten vertically-integrated operators who are near monopolies in their supply areas. After three phases of reform, about two-thirds of power sales have been liberalized (i.e., consumers have a choice of suppliers). The ten utilities remain vertically integrated, but accounting has been “unbundled”, allowing for separate accounting of their network and generation activities.19 Accessibility of private power suppliers to the distribution network has been improved, and the Japan Electric Power Exchange (JEPX)—a spot electricity market for day ahead delivery and forward contracts—was established to encourage supply of wholesale electricity across markets.

27. However, little competition has developed among existing suppliers. For example, among large customers, new entrants account for only 2½ percent of sales (May 2007), and only one of the ten general power utilities is supplying power outside it’s own supply area. Barriers faced by new entrants include high oil and coal prices (the existing utilities have hydro and nuclear plants); high transmission charges; strict “balancing requirements”;20 and the limited volumes traded on the JEPX.

28. Deregulation has resulted in lower electricity prices in recent years, but prices remain high by international standards, suggesting scope for improving efficiency and competition. Discussions on the next round of reforms began in April 2007 with a view to begin implementation by 2008. To improve access for new entrants, the next round of reforms will likely consider among other things: reviewing the balancing requirements and charges, enhancing connection capacity between the networks, further developing the JEPX, and amending the current transmission charge regulation to strengthen incentives for grid investment. As highlighted by the OECD, consideration could also be given to bringing together network operators into a separate firm to enhance infrastructure investment incentives (OECD, 2005).

Gas utilities

29. The natural gas industry in Japan comprises many (mostly private) vertically integrated regional companies, with four major companies meeting nearly 80 percent of total gas demand. The gas pipeline network is fragmented with little connection between regions. Deregulation in gas utilities started in 1995 when supply to large scale customers was liberalized. After two phases of deregulation, about half of the retail market was liberalized by April 2007. An amended Gas Utility Law allowed regulated third party access (TPA) to the pipelines, which was later extended to cover all general gas suppliers and pipeline operators to ensure fair access to gas distribution.21 As of March 2007, there were 28 new entrants supplying gas to the liberalized segment (large scale customers), but they account for only around 12 percent of the liberalized retail volume.

30. Internationally high industrial and household prices for natural gas suggest scope for further reforms. In FY2008, the authorities plan to review past reforms and set the new agenda in which securing gas supplies will be a key theme. As suggested by the OECD, the agenda should aim to deepen competition by enhancing the gas pipeline networks and improving TPA to terminals, such as by moving from negotiated TPA to a regulated TPA approach.

Postal services and telecommunications

31. Japan’s postal services have been liberalized, with free entry into parcel, special, and standard letter segments. In 1985, competition began in telecommunications with the entry of new common carriers in long distance and international services, followed by the privatization of NTT. In 1988, Japan’s mobile phone network was liberalized, and in 2003 telecom services were unbundled (Callen and Nagaoka, 2002; Høj and Wise, 2004). This has resulted in significant competition in some markets. For example, internet access and cellular phone interconnection rates are among the lowest in the OECD. More recently, introduction of number portability for mobile phones has further increased competition among service providers.

32. Further reforms should aim to level the playing field. According to the OECD, further reforms could include establishing independent regulators and leveling the playing field by removing ownership restrictions in telecoms. In postal services, competition could be enhanced by abolishing strict service obligations for general correspondence delivery operations and opening access to the Japan Post’s facilities/services. Measures could be taken to ensure equal treatment for express mail delivery between Japan Post and other companies, such as customs clearance regulations and procedures (United States-Japan, 2007).

Healthcare

33. Initiatives are underway to improve efficiency in healthcare services. They include measures to increase utilization of IT (such as by moving to online receipts and improving availability of information on medical institutions)22 and reduction in approval time for new drugs and medical devices. The Ministry of Health, Labor and Welfare’s “Program for the Improvement of the Quality and Efficiency of Medical Care and Long-term Care Services” (May 2007) targets moving to “online” receipts by FY2011 and increasing the share of generic drugs to over 30 percent by FY2012. While joint-stock hospitals were approved under the Special Zones regulatory reform initiative in July 2005, so far only one has been set up due to the conditions requiring such hospitals to provide highly specialized and advanced medical services not covered by national health insurance.

34. Reforms thus far have had a limited effect on containing healthcare costs which have been rising along with age-related illness and hospital stays. Without for-profit hospitals, the role for competition in promoting efficiency, improving service standards, and containing costs remains limited.

35. Studies by the Cabinet Office suggest greater use of commercial providers and ICT holds much potential for boosting healthcare efficiency. This would involve:

  • Allowing a broader scope for the operation of medical joint-stock companies.23 Consideration could be given to allowing medical joint-stock companies to provide more mainstream medical services in Special Zones, with a view to expanding this nationwide The current stringent conditions on the areas in which medical joint-stock companies can operate limit the potential benefits of private sector participation in healthcare.

  • Improving the functioning of the insurance system. Insurers could play a more active role in the healthcare market as informed agents of patients. Further outsourcing of health insurance could be promoted (Iwamoto, 2003).

  • Reform of the pricing system should aim to improve transparency of the reimbursement pricing system and, through engagement of industry participants, ensure a pricing system that supports innovation in pharmaceuticals and medical devices (EBC, 2006).

  • Better information disclosure. Disclosure and dissemination of information by healthcare service providers, deregulation of advertisement, and mandatory issuance of receipts with descriptions of treatments, would help patients participate in their own treatment in a more informed way (Imai, 2002; Council for the Promotion of Regulatory Reform, 2006).

C. Government Initiatives to Boost Productivity

36. The government’s initiatives to boost productivity in the service sector are spread across several fronts (Box V.2). The June 2007 Basic Policies for Economic and Fiscal Reform outlines a multi-pronged strategy to enhance Japan’s growth potential (aiming to increase labor productivity growth by 50 percent in five years) and reforms to address globalization. The main points are:

  • Boosting productivity. Improved labor utilization and greater dynamism at SMEs and in services will be pursued (among other things) by encouraging the accumulation of human capital and fostering IT investment and utilization. A “job card” system to facilitate hiring decisions and labor mobility through an official record of individual employment and training histories is under development, and long term job seekers will be provided “practical education programs.” Strategies for boosting service innovation include building common infrastructures for e-business; and deregulation (focusing on areas such as medical services). Other elements involve policy innovation (such as the promotion of international joint drug trials, speeding up approval systems, and reforming the drug pricing system), university reform, and innovation reforms.

  • Addressing globalization. To enhance Japan’s growth potential, the authorities aim to: (i) at least triple the number of preferential trade agreements and EPAs in force over the next two years (ii) strengthen competitiveness of financial and capital markets (such as through development of comprehensive exchanges, and reviewing firewall regulations related to banking and securities); (iii) establish an “Aviation Liberalization Timetable” (under the “Asian open sky policy”); and (iv) pursue the Asian Gateway Initiative (which includes reformulating policies relating to foreign students, and promotion of tourism).

Selected Government Reform Plans and Strategies

The Government of Japan’s basic policies aim to energize economic growth through innovation and openness, with policies and structural reforms drawing on the recommendations of:

  • The Council on Economic and Fiscal Policy’s (CEFP) Course and Strategy for the Japanese Economy (January 2007),

  • The CEFP’s Program for Enhancing Growth Potential (April 2007),

  • The Council for the Asia Gateway Initiative’s Asia Gateway Initiative report (May 2007),

  • The Innovation 25 Strategy Council’s Innovation 25 report (May 2007), and

  • The Council for the Promotion of Regulatory Reform’s (CPRR) First Report (May 2007).

The government’s annual Three-Year Plan for Promoting Regulatory Reform (June 2007), which draws on report of the CPRR (May 2007), lists regulatory reform plans or considerations in a wide range of areas. The “focus areas” include: reform of government-driven markets; education; IT, energy and transportation; welfare (child care and nursing care); medical care; competition policy and finance; and labor. The focus areas and some of the plans/considerations in the report are consistent with priorities suggested in this chapter.

D. Conclusion

37 In sum, the objective of boosting service-sector productivity would best be achieved through a comprehensive and mutually reinforcing set of deregulation measures—namely, enhancing frameworks for innovation and ICT utilization, product market reforms (including the sector-specific priorities above), greater labor market flexibility, financial market development, and enhanced competition and regulatory frameworks. The priority service sectors are in distribution (retail and wholesale trade, and transport), networks (which are also key inputs into all other sectors), and health (opening “government-driven markets” in social welfare areas, such as healthcare, to the private sector will be become increasingly important with growing demand in the context of an aging population). The potential returns from broad-based deregulation are substantial and would play an important role in enhancing Japan’s growth potential and international competitiveness.

Figure V.2.
Figure V.2.

TFP Growth and ICT Capital Services Growth by Sector, 1995-2004

(Percent change)

Citation: IMF Staff Country Reports 2007, 281; 10.5089/9781451820706.002.A005

Source: EU KLEMs Database.

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1

Prepared by Yougesh Khatri and Sumiko Ogawa.

2

Services are defined in the broad sense of the tertiary sector, and this chapter focuses on non-financial services.

3

See summaries of the various studies in Callen and Nagaoka (2002), Walker (2004), OECD (2005b), and IMF (2006).

5

Japan’s overall competitiveness ranking according to the World Economic Forum improved from 21 in 2000 to 7 in 2006; and the ranking according to the International Institute for Management Development improved from 16 in 2000 to 12 in 2006.

6

Summary indices of structural rigidities or competitiveness have generally been found to have a significant explanatory power in standard cross-country growth regressions (Porter, 1998; Dutz and Hayri, 2000).

7

The employment protection legislation itself is relatively liberal, but the case law has set a high bar for dismissals in practice (Callen and Nagaoka, 2002).

8

Many of the Special Zone reforms relate to the education sector suggesting demand for greater flexibility. Opening up the tertiary sector would help upgrade competitiveness of Japanese universities (OECD, 2006). Reforms to increase participation rates, improve search, and reduce miss-match (through vocational training etc) would help reduce the negative growth contribution of the labor force.

9

The advisory panel to the government on the competition law recently suggested that surcharges should be set at levels that effectively discourage violations (surcharges are still low compared to EU) and be extended to broader anti-trust violations (such as predatory pricing).

10

In May 2007, the corporate code was amended to allow foreign subsidiaries in Japan to use their parent company shares in M&A. A recent clarification of the tax treatment of such M&A granted foreign subsidiaries under certain circumstances tax-deferrals (as enjoyed by domestic firms). As M&A is a major form of FDI, these are important changes that could boost FDI inflows, depending on how the conditions for foreign subsidiaries receiving the tax deferrals work in practice.

11

For example, starting a business in Japan involves 8 processes, takes 23 days, and costs 7.5 percent of GNI per capita, compared to 5 processes, 5 days, and only 0.7 percent of GNI per capita in the United States.

12

The low TFP during the 1990s probably reflects, at least in part, cyclical factors and structural problems during the “lost decade.”

13

Innovation 25 is a long-term government strategy aimed at boosting innovation and potential output through regulatory and other reforms—see Box V.2.

14

The OECD summary index for restrictiveness of retail distribution regulation improved from 5.1 in 1996 (the highest among the major industrial economies), to 2.4 in 2003 (within the range of the other major industrial economies). This improvement was mainly driven by reduced barriers to entry and operational restrictions.

15

Possible factors behind the small average store size include: (i) regulations on large-store entry; (ii) elements of the tax system that may discourage the exit of “mom-and-pop” stores; (iii) SME debt guarantees provided by the government under favorable terms; and (iv) benefits to traditional stores under the City Center Revitalization Law, such as financial support for building parking. (OECD, 2006; p. 154).

16

Restrictions on large scale stores are the main market entry restriction in OECD countries and are generally motivated by concerns about environmental impact and urban planning. Such restrictions can slow consolidation and modernization of the sector; hinder efficiency gains from scale economies; help incumbents maintain dominant positions; and reduce firms’ market power over suppliers (Boylaud and Nicoletti, 2001).

17

Foster, Haltiwanger, and Krizan (2006) find the contribution to overall productivity of “entry” to be greater than that from continuing establishments, and that large retail stores play an especially important role. Matsuura and Motohashi (2005) found for Japan that market entry of large supermarkets, and specialty stores, and convenience stores had a statistically significant positive effect on overall productivity in the retail sector.

18

See OECD (2004; 2005) and United States - Japan Business Council 2006 Policy Statement.

19

Vertical structures were maintained in order to secure stable supply and promote nuclear power generation. The approach has been to legally establish “information firewalls” (accounting unbundling) and prohibit cross-subsidization or discriminatory treatment. A Neutral System Organization (NSO) was established consisting of incumbents, new entrants, network users, and academic experts, to ensure the neutrality of governance (through formulating rules and monitoring implementation).

20

Non-owner users of transmission network are required to contain the gap between demand and supply below certain levels within a window of time (usually a demand-supply gap of less than 3 percent in a 30 minute period—the range can however be negotiated).

21

To encourage new investment in pipelines, new pipelines are exempted from TPA obligations, or be allowed to charge higher rates, for a limited time.

22

In March 2007, the revised “Grand Design for the Use of Information Technologies in Medical, Health, Long-term Care, and Social Welfare Fields” was announced (an update of the 2001 plan).

23

The Three Year Plan for Promoting Regulatory Reform of June 22, 2007 also considers this. Imai (2002) suggests that restrictions on service provision should be eased substantially to promote restructuring—including direct restrictions (such as on the number of hospital beds, medical students, etc), and indirect restrictions, notably the prohibition on “for-profit” companies running hospitals.

Japan: Selected Issues
Author: International Monetary Fund
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    Service Sector Share in GDP and Employment

    (in percent)

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    Labor Productivity Gap between Japan and the United States

    (by industry)

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    OECD Product Market Regulation Indicator

    (ranging from 0 (least restrictive) to 6 (most restrictive))

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    Share of Services in Businesses R&D, 2003

    (in percent)

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    Major Industrial Countries: TFP growth and ICT capital services growth, 1995-2004

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    Contributions to Growth

    (in percent; 2000-05 average)

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    OECD Non-Manufacturing Product Market Indices (NMR)

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    TFP Growth and ICT Capital Services Growth by Sector, 1995-2004

    (Percent change)